This Cloud Sector Will Rain Profits

More and more companies are relying on the cloud for talent-management solutions, says Rob DeFrancesco ofTech-Stock Prospector.

At the recent Barclays tech conference, Cornerstone OnDemand (CSOD) CFO Perry Wallack said he wasn't trying to be boring, but that he is looking for more of the same this year.

When more of the same means revenue growth of greater than 50%, no one is going to be falling asleep.

It doesn't hurt that Cornerstone shares are up 38% so far in 2013. The company has fast become a leading cloud player in talent management, with solutions covering learning, performance management, and recruiting.

More than 60% of Cornerstone customers buy elements from at least two of its clouds. About 80% of the installed base uses the company's learning cloud, while the performance-management rate is roughly 66%.

The sales force is successfully selling recruiting (introduced early last year) into the base, thanks to the solution's social-tools focus.

Wallack said Cornerstone estimates that there are 300 million potential seats. The company is now at 11 million, while competitors control roughly 40 million.

So the market is now only 17% penetrated, with Cornerstone having just a 3.6% share. Even assuming no market growth or pricing power from here, Wallack said Cornerstone is looking at a 6x growth opportunity.

In the first quarter, Cornerstone's revenue rose 57.1% to $37.7 million, and bookings advanced 50% to $35.9 million. Deferred revenue grew 62%, to $90.5 million. Cornerstone increased its customer base by 48% to more than 1,300. Gross margin was 72.2%.

Per-user pricing for each individual product offering is rising. Cornerstone is also seeing more full-suite deals encompassing recruiting, learning and performance management, across both the enterprise and mid-markets.

With the June software update, the company's recruiting cloud is expected to get even more competitive on a standalone basis, featuring an improved user interface and collaboration enhancements.

The learning cloud continues to be a significant sales driver for Cornerstone. Wallack said the company often gets called into deals in Europe, because learning is now deemed a strategic solution, and Cornerstone's offering is the best on the market.

Customers see the ROI advantages of going with a specialist such as Cornerstone, instead of a large Enterprise Resource Planning (ERP) vendor that takes a generalist approach in this critical segment.

Pacific Crest recently raised its price target to $50, because the firm has increased confidence that the company can hit $500 million in revenue in a $31 billion addressable market over the longer term, particularly because of easing competition. Deal sizes are increasing, and the company's client relationships are deepening, according to the firm.

Meanwhile, the Pacific Crest analyst believes Taleo has become a weakened competitor following its buyout by Oracle (ORCL), while SuccessFactors (now owned by SAP (SAP)) has remained competitive, but is not seeing success with its price discounting, and is still losing deals to Cornerstone, because SAP is more focused on a suite-based, generalist sales approach.

Pacific Crest thinks the company is getting even more dominant in its core learning segment, as Taleo discontinued its Learn.com solution, and SuccessFactors has deemphasized its Plateau solution. Pacific Crest says its checks indicate Cornerstone is replacing Plateau at an accelerating rate.

For 2013, Cornerstone sees revenue of $181 million to $183 million (representing 54% growth at the midpoint), up from the previous guidance of $179 million to $182 million. The company is expected to lose money again this year, but turn profitable in 2014.

With a low 5% gross churn rate since inception, Cornerstone can count on most customers sticking around for the long term, leaving plenty of room for margin expansion in the years ahead.